January 2023 / VIDEO
Five Important Insights From 2022
The Fed is determined to fight inflation and yield is back, but socially oriented goals could impact economic policies in China.
- The Fed is committed to do whatever it takes to curb inflation. Meanwhile, a focus on socially oriented goals could impact economic policies in China.
- The rout in bonds helped to restore healthy yields but reminded investors that stocks and bonds can sometimes sell off at the same time.
We have learned a lot during 2022, including these five important insights that investors should keep in mind as we enter 2023.
1. Valuation matters.
Equity markets sold off sharply in 2022 despite earnings expectations only falling modestly. This is because equity valuations were too high going into the year. Once investors recognized that interest rates would be rising sharply in the future, valuations adjusted sharply downward. Unfortunately, this means that if earnings expectations fall sharply during 2023 due to a global recession, the sell-off that we have already seen in stocks could get worse.
2. The Fed will choose fighting inflation over supporting the economy.
Market expectations for the Fed were consistently too low during 2022. And we still don’t yet know how high they will raise rates during this cycle, nor do we know how long they will hold them at elevated levels. But we do know that they do not want a replay of the 1970s. They are willing to do whatever it takes to get inflation back to healthy levels, even if that means pushing the U.S. economy into recession. Their primary focus will be on bringing wage inflation lower in 2023. We should not expect them to back off if the economy shows further signs of weakness unless the labor market also weakens considerably.
3. China has changed.
2022 proved to be a year of considerable change in China, with the extended leadership of President Xi Jinping. Notably, the government has indicated that while economic growth remains important, it will reinvigorate socially oriented goals. This could lead to less predictable economic policy changes in the future. We were surprised by the easing of COVID restrictions in December and investors should be prepared for more uncertainty going forward.
4. Stocks and bonds can go down at the same time.
Bonds have historically offered ballast to investors’ portfolios when equities faltered. But this is not always the case, particularly when the Fed embarks on a new hiking cycle–which is, of course what transpired in 2022.
However, it should be noted that 2022 was somewhat of an outlier for two reasons:
- The Fed usually tightens when economic growth is accelerating, which was not the case in 2022.
- The Fed usually tightens much more gradually than they have this time around.
Fortunately, stock/bond correlations look likely to fall in 2023 as the Fed appears close to the end of its hiking cycle.
5. Yield is back.
The silver lining to the rout in bonds during 2022 is that bonds have healthy yields once again. This means investors no longer have to take significant credit risk to get a healthy yield from their bond portfolio, and it also means there is a larger income buffer that can help to offset any further increases in interest rates and/or credit spreads.
As we move into 2023, we will be closely monitoring all of these issues and will update you accordingly as they play out.
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